Keeping the Liability of Your Business Limited After Formation

November 3, 2010

The primary benefit of incorporating your business or forming a LLC is limiting your liability to your investment in the business. In the event that a corporation or LLC is sued, the business can only lose its own assets and shareholders or members cannot be held personally liable for the debt. Limited liability is possible because the law perceives a corporation or limited liability company a separate legal person from its members or shareholders. Given this general rule, business owners might be surprised to learn that in some circumstances courts will disregard that separate entity and hold shareholders and members personally liable.

Courts will "pierce the corporate veil" where it perceives a business entity as being no more than an extension, or "alter ego" of the owners. Courts will consider factors such as lack of investment in the business, failure to adhere to normal corporate formalities, such as making bylaws, keeping corporate minutes, holding annual shareholder meetings, electing directions, and owners using corporate accounts to pay personal bills. In such cases the business looks less like its own entity and more like an extension of an owner.

Now you might be thinking that it would be easy to avoid such treatment by forming an LLC. In that case there is no "corporate veil" to pierce.   The official notes to Pennsylvania’s LLC law; however, states that "in the appropriate case the doctrine of piercing the corporate veil will be applied to a limited liability company.” Regardless of which entity is chosen, it is possible for an owner to be held personally liable.

This highlights the importance of continuing legal counsel for businesses after formation to maintain limited liability status. Even a corporation or LLC with one member or shareholder can avoid losing limited liability status by keeping compliant with general formalities, such as holding shareholder meetings, keeping minutes, forming bylaws, and making sure to only use the company account for company business. In such cases it is easy to establish that the business was its own entity and not the "alter ego" of the owner(s).